Government Proposes Legislation to Enhance UK Insolvency Regime
On 26 August, the Government announced that it will be making changes to UK insolvency legislation. The changes are intended to support distressed companies and address issues highlighted by major company failures and include:
- the ability for all companies to apply for a moratorium
- a new insolvency process – the “restructuring plan”, enabling companies to cram down creditors
- a prohibition on suppliers enforcing termination provisions in contracts and licences upon insolvency
- an increase in the prescribed part
- a change to the requirement to prove insolvency on a preference claim.
However, legislative changes are unlikely before 2019 given that implementation depends on parliamentary time, which is currently engaged with Brexit.
More time for business rescue as the Government introduces a moratorium for all companies
Under the reforms, subject to a company fulfilling (a) eligibility criteria and (b) qualifying conditions all companies will be able to obtain a moratorium, allowing companies time to formulate restructuring proposals without creditor pressure.
The process for obtaining a moratorium will be akin to a directors’ out of court appointment of administrators and will require the company to file papers at Court accompanied by consent to act from an insolvency practitioner (“IP”) confirming that the eligibility and qualifying criteria has been met. Creditor consent is not required.
Once the papers are filed, the moratorium will come into effect.
The IP – “the monitor” – will then notify all creditors and register the moratorium at Companies House and has to ensure that the company continues to meet the qualifying conditions during the moratorium. The company remains in the directors’ control during the moratorium which initially lasts for 28 days unless extended (with monitor approval) for up to another 28 days. Beyond 56 days, 50% of secured and 50% of unsecured creditors must consent to any further extension, although the company can apply to court if consent is impracticable.
The moratorium will lapse (1) at the end of 28 days (or any extended period), (2) when the company enters a formal process, (3) when creditors agree a workout or (4) the IP concludes that the qualifying conditions are no longer being met.
To address concern that the process could be abused, the company has to show that it will become insolvent if action is not taken, thus excluding companies which are already insolvent and those which have short-term cash flow issues. It will also have to demonstrate that “rescue is more likely than not”. Whilst creditors can challenge the moratorium at Court, the fact that the company (in filing for the moratorium) has to demonstrate that it has sufficient funds to carry on its business and meet obligations as they fall due should provide comfort to creditors. Further, any supplier which remains unpaid for supplies made during the moratorium will be afforded super-priority and paid as an expense if there is a subsequent insolvency, ahead of insolvency practitioner fees.
The new moratorium will not be available if the company has entered a moratorium, administration or CVA in the previous 12 months. However, unlike in administrations, it will be available to companies if a winding up petition has previously been presented. The Court will also have discretion to grant a moratorium if there is a pending winding up petition. Consequently, s127 of the Insolvency Act 1986 will be amended enabling payments to be made during the moratorium without a validation order and the monitor will also have authority to sanction the disposal of assets outside of the normal course of business.
There will be no cap on a monitor’s costs, which are a matter of negotiation between the monitor and the company and any unpaid costs will rank as an expense in any subsequent insolvency (behind suppliers). However, an IP will not be able to take an appointment as liquidator or administrator of the company unless 12 months have elapsed since the end of the moratorium – although the IP can act as supervisor of a CVA and would not be prohibited from advising on the proposed new “restructuring plan”.
Directors will need to ensure that they understand their duties during the moratorium, including the proposed new obligation to provide any information which the monitor may reasonably require, given that liability under s214 for wrongful trading will not be suspended as was proposed. The Government has, however, confirmed that it intends to bring forward proposals to strengthen access to training and guidance for directors and will also consider whether to make training mandatory for directors of large companies.
The new measures should please company directors because they support business rescue without being overly prescriptive and without the stigma associated with a formal process. The process also aims to be transparent and for that reason, it should receive creditor support. As part of that transparency, creditors will be entitled to information about the process, but what and how that will be provided is still up for debate as the Government considers how to strike the right balance between keeping creditors informed without interfering with or distracting from the rescue process.
New rules will prevent suppliers terminating contracts on insolvency
Akin to the law in Australia, a new provision will be introduced which prevents suppliers from enforcing termination clauses upon an insolvency event. This is to prevent suppliers terminating a contract and jeopardising the ongoing viability and rescue of a business, although it will not prevent suppliers terminating on other non-insolvency grounds if they exist.
The proposed new rule will also apply to contractual licences, such as software licences, although it will not extend to licences issued by public authorities and equally, finance providers will be exempt from the new provisions.
It is intended that suppliers will not being exposed, given that supplies made during an insolvency process are already payable as a high priority expense and a supplier can apply for an exemption if their interests are prejudiced by the effects of this new provision, but they will have to demonstrate that the effect of the rule threatens the supplier’s own solvency.
The proposed rules will also apply during the new moratorium, although suppliers should take comfort that (1) one of the qualifying conditions for the new moratorium requires the company to show that it can pay its debts as and when they fall due and (2) if the company enters a formal process before the debt is paid, unpaid supplier costs are payable as a super-priority expense ahead of other unpaid moratorium costs, including unpaid monitor costs.
A new type of “insolvency” process
The Government plans to introduce a new restructuring plan enabling companies to bind all creditors (including secured creditors) whether or not they vote in favour of the plan, through the use of “cross-class cram down” – a process used in the US in Chapter 11 proceedings – the effect of which enables companies to bind dissenting creditors. It will also extinguish creditors’ rights on approval so that in any subsequent insolvency, they can only assert their rights and claim as provided for in the plan.
The new regime will be available to all companies, both solvent and insolvent and can be proposed by the company or an office holder if already in insolvency process. It is available in addition to or separately from the new moratorium.
Dissenting creditor claims must be paid in full before more junior classes and at least one class of impaired creditor must vote in favour of the plan. This, coupled with the requirement for the plan to be approved by creditors, shareholders and the court, should ensure that the interests of minority creditors will not be unfairly prejudiced.
Increase to the prescribed part
There will be an increase to the cap on the prescribed part increasing this from £600,000 to £800,000 in line with inflation. An increase is welcome, since the cap has remained at £600,000 since it was first introduced in 2003 but (as the Government acknowledges in the Response) it will likely only have an impact on a small number of cases because the cap is rarely reached. However, an increase to £800,000 does little to plug the gap on big corporate failures, where unsecured creditors run into the millions.
Some respondents to the consultations had hoped that the prescribed part would be index linked, but a balance had to be struck between avoiding a windfall payment to floating charge holders and the impact that a significant increase may have on the lending market.
In order to align TUV and preference claims, an office holder will no longer be required to prove that a company was insolvent at the time of or became insolvent as a consequence of a preferential payment to a connected creditor – insolvency will now be presumed.
Whilst it seems sensible to align the two, in reality it may not make much difference. The change will give an office holder a stronger starting position and bolster negotiating strength but given that the presumption is rebuttable it is always best practice to obtain evidence of insolvency in any event.
New power for the Secretary of State to pursue directors of dissolved companies
In order to address the fact that the conduct of directors of dissolved companies cannot be investigated without restoration of the company, the Government will extend powers under the Company Director Disqualification Act 1986 to enable the Secretary of State to investigate and pursue disqualification action without the company being restored.
It is likely that the new power will be triggered by a complaint/as a result of an issue identified in an existing investigation and will be targeted at public interest cases.
This new power was supported by many and hopefully will operate as a deterrent to unscrupulous directors who seek to liquidate a company to avoid investigation into their conduct. It will be interesting to see if it operates as a deterrent, given that it is reliant on third parties notifying the Secretary of State and whether there is funding to pursue such action.
Claims against directors of holding companies
The Government also intends to introduce new measures which will enable disqualification action to be taken against directors of a holding company if, following the sale of a group subsidiary, the subsidiary enters into liquidation or administration within 1 year of completion of the sale.
The proposed changes will be primarily aimed at directors of large corporates who sanction the sale of a subsidiary without proper consideration or regard to the interests of the subsidiary’s stakeholders – the legislation is not intended to target directors who believed the sale would “likely deliver no worse outcome for stakeholders” than entry into an insolvency procedure.
There may be further changes as the Government continues to monitor, consult and work with key stakeholders and it has been indicated that further consultation is likely. We will have to wait and see what further reforms and proposals will be tabled, but they may include further changes to shareholder responsibilities, a review of the dividend regime and clarification of or new powers under the Insolvency Act to pursue delinquent directors.
Overall, the proposals are positive, offering flexibility and encouraging companies in distress to seek help and support earlier. Coupled with further reforms requiring greater corporate transparency and with a focus on director accountability, the proposals should cement the UK’s reputation for having a good and reliable insolvency regime and encourage business to the UK, which in the uncertain arena of Brexit is welcome.